While there’s a lot to like about FHA loans, they may not be right for everyone. Before you make a major financial commitment, it’s important to understand the pros and cons of FHA loans. Only then can you truly decide whether it’s right for you.
As a first-time homebuyer, I spent a lot of time researching different mortgage options to finance my home purchase. The FHA loan kept coming up as a top choice for buyers like me with a lower credit score and without much cash for a down payment.
At first glance, FHA loans seem great They offer low down payments, flexible credit requirements, and reasonable interest rates However, once I dug deeper, I realized FHA loans come with some significant drawbacks that made me hesitant.
In this article, I’ll walk through the key cons of FHA loans based on my own research and experience. As you weigh whether an FHA mortgage is right for your home financing needs, make sure you consider these potential pitfalls
The Main Disadvantages of an FHA Mortgage
Upfront and Ongoing Mortgage Insurance Premiums
One major downside of FHA loans is that you have to pay mortgage insurance premiums (MIP) for the life of the loan. There’s both an upfront MIP you pay at closing and an annual MIP included in your monthly payments.
On a $200,000 loan, you’d have to cough up around $3,500 upfront for mortgage insurance. Then you’d pay around $100 per month in MIP as part of your regular mortgage payment. Over the life of a 30-year loan, that adds up to over $36,000!
With a conventional loan, you can usually drop mortgage insurance once you build 20% equity. But with an FHA loan, you’re stuck paying the monthly premium for the full term.
Lower Loan Limits
FHA mortgage amounts max out lower than conventional loans. How much lower depends on where you’re buying.
In 2023, the baseline FHA loan limit for a single-family home is $420,680 For expensive areas, you may qualify for up to $970,800 With a conventional mortgage, limits range from $647,200 to $970,800.
If you need to borrow more than $420,680, an FHA loan won’t cut it. You’d have to explore other options like a jumbo loan.
Stricter Appraisal Guidelines
To get an FHA loan, the home you buy must pass strict appraisal standards regarding its safety and condition. Even minor issues like chipped paint, faulty railings, or a leaky roof could cause the property to fail.
If the appraisal uncovers problems, you can’t move forward until they’re fixed. This can delay closing or blow up the deal altogether. Conventional loans tend to have more relaxed appraisal criteria.
Longer Processing Times
Due to extra documentation requirements and underwriting rigor, FHA loans often take longer to close than conventional mortgages. It’s not uncommon for the FHA approval process to drag on for 60-90 days.
If you’re in a time crunch to secure financing and close on a home, an FHA loan may leave you waiting at the finish line longer than you’d like. You may be better off with a conventional mortgage you can close faster.
Government Oversight
With an FHA loan, you have to follow more rules and regulations enforced by the Federal Housing Administration. For instance, you must move into the home within 60 days of closing and live there as your primary residence.
If you want to rent out the property, refinance, or make major renovations, you need FHA approval. The FHA places limits on what you can do with the home until you build enough equity to no longer need mortgage insurance.
Some borrowers don’t like having the government looking over their shoulder throughout the life of the loan. They would rather have the freedom of a conventional mortgage.
Who Should Think Twice About an FHA Loan?
As we just covered, FHA loans can make homebuying more accessible thanks to low down payments, flexible credit requirements, and reasonable interest rates. However, the mortgage insurance premiums, strict approval process, and government oversight may give certain buyers pause.
Here are a few homebuyer profiles who may want to look at alternatives beyond FHA financing:
-
Borrowers with excellent credit (720+ scores) – You can likely qualify for a conventional loan with lower interest rates and no mortgage insurance requirements.
-
Repeat homebuyers with equity – You may have enough equity from a prior home sale to put 20% down on a new place. That would help you avoid mortgage insurance on a new loan.
-
High earners buying pricier homes – FHA loans max out at $420,680 in most areas. If you need to borrow above that, you’ll have to consider a jumbo loan or other option.
-
Investors or vacation home buyers – FHA loans are only for primary residences where you live at least 9 months per year. You can’t use them to buy rental properties or vacation homes.
-
Borrowers wanting a cash-out refinance – You generally need to have 20% equity to do a cash-out refi with an FHA loan. With a conventional loan, you may only need 15% equity.
-
Homebuyers needing flexible condo approval – Condos must meet FHA owner-occupancy and budget requirements. That limits FHA financing options for some condos.
-
Anyone wanting to avoid mortgage insurance – Conventional loans let you drop mortgage insurance once you build 20% equity. FHA loans require it for the full term.
-
Borrowers wanting a quicker close – Conventional loans often close faster than FHA loans. If time is of the essence, a conventional mortgage may better suit your needs.
Alternatives to Consider Over an FHA Loan
Here are a few alternatives I would suggest exploring if the cons of an FHA mortgage currently outweigh the pros for your situation:
Conventional 97 Loan – This offers the low 3% down payment of an FHA loan without the mortgage insurance. You will pay a slightly higher interest rate and closing costs. But you won’t have to fork over thousands in upfront and ongoing MIP.
Down payment assistance programs – These programs offered by nonprofits, states, and employers provide grants or low-interest loans to help cover your down payment. When combined with a conventional loan, you get the benefits of low down payment without the FHA strings attached.
VA or USDA loans – For qualifying borrowers, VA and USDA loans offer zero down payment options without the permanent mortgage insurance of an FHA loan.
Family gift – If you have family able to gift you additional down payment funds, you may cross the 20% down threshold. That would allow you to get a conventional mortgage with no mortgage insurance required.
Wait to improve your credit – Taking some time to boost your credit score could open up better conventional loan options with fewer drawbacks than an FHA mortgage.
Buy a lower-priced property – Opting for a less expensive home that you can put 20% down on makes avoiding FHA mortgage insurance easier. Run the numbers to see if this strategy works in your area.
Save up a bigger down payment – The more you can put down upfront, the less painful mortgage insurance will be on an FHA loan. Though you can’t escape it completely, you can reduce the costs.
The Bottom Line
As a first-time buyer with a thin credit file and budget, I initially thought an FHA loan was my clear choice. But upon learning about the mortgage insurance premiums, strict approval criteria, and loan limit caps, I had reservations.
In the end, we opted for a down payment assistance program paired with a conventional mortgage. This provided the low 3.5% down payment we needed without saddling us with permanent mortgage insurance.
While FHA loans allow many buyers to break into homeownership, they aren’t the universally best option. The key is weighing the pros and cons based on your specific home buying goals and financial situation. Don’t be afraid to think outside the FHA box and get creative with your financing if needed.
What potential pitfalls of FHA loans concern you the most? Share your thoughts in the comments below!
Lower Credit Score Requirements
Many people with bumps in their credit history worry that they wont be able to qualify for a home loan. Luckily, FHA loans are available to borrowers with less-than-ideal credit.
Most lenders will write FHA-backed loans for borrowers with credit scores of 580 or higher. If you’re in the 500-579 range, don’t despair. You can also qualify for an FHA loan, but you may need to come up with a 10% down payment instead of the standard 3.5%.
Note: Paddio currently looks for credit scores of 620 and above.
FHA loans are also sometimes a good option for people who have recently gone through a foreclosure or bankruptcy. Depending on your circumstances, you may be able to qualify for an FHA loan within one to two years after the incident.
FHA loans don’t have any minimum or maximum income requirements. This is a unique benefit not found in many other mortgage products, aside from the USDA loan. This means that higher-income earners with credit problems can still qualify for FHA loans. Even if you make a substantial salary each year, you can still benefit from the lower down payment and relaxed approval requirements.
You can use an FHA loan to purchase multiple types of properties. This includes single-family homes, condominiums on permanent land, manufactured homes on permanent land and multifamily homes with up to four units – though you may have a hard time finding a lender willing to do a manufactured loan.
This gives you plenty of options and some room to get creative. For example, you could buy a multifamily home and use the rent you would charge on the other units to qualify for the loan, as long as you live there as well.
Note: Paddio does not offer FHA financing for manufactured homes
If you put less than a 20% down payment, most conventional loans require you to carry Private Mortgage Insurance (PMI). This insurance provides the lender protection in case you fail to repay your loan. The premiums for PMI are often much higher if you have bad credit. With an FHA loan, however, you’ll pay the same insurance premium regardless of your credit score. If you’re credit-challenged, this could save you a significant amount of money over the lifetime of your loan.
Advantages and Disadvantages of FHA Loans
| Pros | Cons |
|---|---|
| Low Down Payment | Loan Limits |
| Low Credit Score Requirements | Higher Mortgage Insurance |
| No Income Limit | Strict Property Standards |
| Multiple Housing Options | Occupancy Requirements |
| Low PMI | Continuing Mortgage Insurance |
The Good and BAD of FHA Loans | NEW FHA Loan Requirements 2023
FAQ
What are the downsides of an FHA loan?
Why would a seller not want an FHA loan?
Is it a good idea to get an FHA loan?
What can’t you do with a FHA loan?
Why can’t I get an FHA loan?
Common reasons that borrowers don’t qualify for an FHA loan include having too high of a debt-to-income ratio or too low of a credit score. What are the disadvantages of the FHA loan?
What are the advantages and disadvantages of FHA loans?
Here are some of the **advantages** and **disadvantages** of FHA loans: **Advantages:** – **Low down payment**: FHA loans require a minimum down payment of 3.5% of the purchase price, which is lower than
Are FHA loans a good idea?
FHA loans often require lower down payments and credit scores than conventional loans. First-time homebuyers and those with lower credit scores may particularly benefit from FHA loans. FHA loan amounts are limited, and FHA mortgage insurance premiums add up over time. What is an FHA loan?
Can you get a FHA loan with a low credit score?
FHA loans have more flexible requirements than other types of mortgages. It’s possible to qualify with a credit score as low as 580 and a down payment of just 3.5%, or a score as low as 500 if you have a 10% down payment. But whether or not you’ll qualify depends on your finances as a whole.